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Should Price Reflect Cost? (Part 2)

When it comes to pricing, higher education and health care have much in common

In Part I of this post, we discussed how the “high cost/high aid” model of price and cost in higher education has led to growing educational debt and a widening achievement gap between affluent and low-income students. This week, we’ll talk about how (and why) to change this model.

But first: consider the following hypothetical conversation between an admissions officer and two prospective students, as he explains the college’s financial aid policy:

“Steve, Fred, I have good news for both you. You are both being offered admission here at Rippov College! Congratulations! Steve, because your test scores are fully 100 points higher than the average score of students at Rippov, we are offering you a merit scholarship of $16,800, reducing your tuition to just $23,200. Fred, because your test scores are almost 100 points lower than our average score, and because your family’s income is just a bit over the level that would trigger need-based aid, we’re going to have to ask you to pay $40,000. That will cover not only our cost to educate you, but also allow us to give $16,800 of your money to Steve, here. It’s ironic that your father works for Steve’s father, and that Steve went to a better high school in a more prosperous town, and that Steve’s family spent quite a bit of money on prep courses for the standardized test — money that your family didn’t have — and finally, that you’re going to have to borrow a lot of money to pay your tuition bill, but that’s the way things work in the wonderful world of higher education.”

Of course, there never would be such a conversation, if only because it would represent a truly terrible marketing strategy. But that’s in fact what happens at college after college — students whose high school rank (or GPA) and test scores improve the college’s image are rewarded, without any showing of need, by redirecting money from other students with somewhat lower scores, who may, in fact, have to borrow significant sums to enable the college to have the pot of money it needs to reward the stronger students.

My personal view of this arrangement is that it is, at best, unethical, and, at worst, immoral.

I do not believe it is ethical to ask any student to pay for more than what they are receiving. It would be more honest if we priced tuition at the same figure as our educational cost — and then taxed weaker students thousands of dollars in order to create the pool of funds we wanted to have available to lure stronger students — but I suspect such an arrangement would cause a revolt.

Instead, we operate like many department stores: we add a considerable markup over our actual cost, in the hope that some number of customers will pay the full price, and then we begin to discount that price to entice other customers to buy the rest of our stock (in our case, seats in classrooms) as it ages (in our case, as the annual admissions cycle nears the end). As long as our average price exceeds our cost, we’re fine.

But, you may protest, surely it is the case that all colleges augment what they receive from tuition with money from their endowments, from excess revenue from room and board, from summer rentals of school facilities, and so on. And what’s wrong with rewarding students who work hard to do well in high school? Well, all of that is true — but misleading.

First, on average, only about 10 percent of the funds colleges use for institutional financial aid come from these other sources — meaning that 90 percent of the funds come from the students and their families in the form of the “tax” they pay (and by “tax” I mean any money that exceeds the institution’s costs).

Second, there is, in my mind, nothing ethically objectionable to a college using earnings on an endowed scholarship to reward high-achieving students, regardless of whether or not they demonstrate need. But let’s recognize that students from affluent (top quarter of family income) have built-in advantages over students from economically deprived (bottom quarter of family income):

Standardized test scores correlate more with socioeconomic level than with predicting ultimate success in college — and the higher the socioeconomic level, the greater proportion of college-educated parents — so prospective college students from higher socioeconomic levels benefit from greater affluence, better high schools, and parents who know how to facilitate a college experience for their children.

Families in the top quarter of family income spend almost seven times more on “enrichment activities” for their children (including prep courses for the standardized exams) than do families in the bottom quarter.

The graduation rate of students with below-average test scores, but who are from the top quarter of family income, is 30 percent, as contrasted to the 26 percent graduation rate of students with above-average test scores, but who are from the bottom quarter of family income.

To charge one group of students a surcharge in order to offer another group of students a discount — especially where the former group is less affluent than the latter group — is, I will say again, unethical. And it is contributing to the growing stratification of American society. Those of us who expected that a college education would be the primary way by which talented and ambitious young people climbed the socioeconomic ladder have been sorely disappointed — that expectation simply hasn’t happened, and it is past time that we asked “why?”

Here is part of the answer: over the past 30 years, the growth in tuition discounting to create more and larger merit awards has caused a widening of the gaps in college completion rates for students with high versus low levels of family incomes. High sticker prices scare away low-income students; for those who do apply and are accepted, too often huge debt levels cause them to drop out before graduation.

What to do? Well, let’s start by creating an expectation that no college will charge any student more in tuition dollars than it is actually spending to educate the student. Some of our best colleges do this now, but they are in a minority.

Roger Williams University is, I am proud to say, in the vanguard of this movement. For the current year, our tuition sticker price is $29,900, and our annual educational cost is $28,600. Today, 93 percent of our students are receiving some level of institutional aid, meaning that only 7 percent are full-payers. However, by freezing tuition, as we have announced we are doing, and by augmenting what we are spending through other revenue sources, we estimate that within two years, all of our students will be receiving some level of subsidy.

Now it’s time for the rest of higher education to step up.

Until that day happens, colleges will continue to follow a model used by the American health care system. If you have health insurance, your health insurer has a negotiated price with a medical provider for a given medical procedure. Presumably, that price matches up reasonably well with the provider’s actual cost. (This is roughly equivalent to how colleges get to their net tuition.)

Of course, if you have health insurance, the health insurer pays the bulk of the cost of the procedure. (This is akin to being awarded a substantial scholarship — your cost is now considerably less than the college’s net tuition figure.)

But if you don’t have health insurance, you lose twice: once by not benefiting from the discounted price that was negotiated by the insurer, but which is not available to you, because you are not represented by the insurer, and once by being obligated to pay the entire inflated price yourself (no insurance, remember). This is analogous to the student who receives no discount, and must pay the sticker price for tuition, a figure substantially above the cost of his or her education.

So higher education is following the much-disparaged pricing model of health care in America. Analogizing higher education to health care should be all the motivation we need to change the system.

Disclosure of Material Connection: Some of the links in the post above are “affiliate links.” This means if you click on the link and purchase the item, I will receive an affiliate commission. Regardless, I only recommend products or services I use personally and believe will add value to my readers. I am disclosing this in accordance with the Federal Trade Commission’s 16 CFR, Part 255: “Guides Concerning the Use of Endorsements and Testimonials in Advertising.”